The State of Reform for State Credit Unions

The nation’s state-chartered credit unions have a long and successful history in the nation’s financial services industry. The first state credit union act was signed in Massachusetts in 1909. By 1934, forty-two states had enacted legislation to authorize state credit unions. This is the same year credit union dual chartering began with the signing of the Federal Credit Union Act, which authorized federal credit unions.

Today, there are 3,065 state-chartered credit unions in 47 states with a combined $404 billion in assets. [1] State-chartered credit unions represent 40% of the nation’s nearly 7,700 credit unions.

On October 14, I appeared before the Financial Institutions Subcommittee of the Senate Banking, Housing, and Urban Affairs Committee, joining my federal and state regulator counterparts to provide an update on the condition of state-chartered credit unions and state regulators’ perspectives on regulatory reform.

I explained to the Subcommittee that, like all financial institutions, state-chartered credit unions continue to be adversely affected by the economic downturn. However, at this point, state-chartered credit unions remain generally healthy and continue to serve the needs of their members and their communities. For the most part, state-chartered credit unions did not engage in many of the practices that precipitated the current market downturn.

However, that being said, state regulators remain concerned about the impact of the economy, federal regulatory reform efforts, and capital needs for state-chartered credit unions.

Impact of the Economy

Nationally, the average credit union net worth is 10.03%, 98 basis points lower than a year ago, with 96 percent of all federally insured credit unions having more than 7% in capital as of June 30, 2009. Further, the percentage of delinquent loans is 1.58% for all credit union loans. [2]

Growth of deposits is affecting state-chartered credit unions’ asset growth, up 15.77% since December 31, 2008 and up 18.64% nationally. I attribute this growth to the consumer “flight to safety” trend. In my home state of Vermont, the growth of deposits is up 24.73% as of June 30, 2009.

The National Credit Union Administration (NCUA) reported in its Financial Trends in Federally Insured Credit Unions for January-June 2009 an annualized asset growth rate of 14.53%. This growth gives rise to concerns about interest rate risk and the need to ensure quality assets and proper asset liability management by credit unions.

Income is also being reduced as margins are squeezed and credit union members are struggling to make loan payments.

The influence of the economy on state-chartered credit unions varies from region to region. Some regions are weathering significant impacts from the destabilized real estate market, while others are addressing more localized economic issues. In many cases, state regulators are concerned about unemployment and its impact on members’ ability to meet their obligations. State regulators are also concerned about the growing number of delinquencies, charge-offs, and pressures on earnings, especially in smaller state-chartered credit unions. While loan delinquency and net charge-offs have generally increased for state-chartered credit unions, state regulators indicate that the levels remain manageable.

State regulators also report increased scrutiny of consumer credit products, including auto loans, credit cards, and other consumer credit portfolios given the nation’s economic condition. The weak economy has created pressure on member business lending, an issue being closely monitored by state regulators.

Some states, including my home state of Vermont, have not experienced the fallout from commercial or subprime lending as our state-chartered credit unions did not engage in those activities. State regulators continue to encourage their credit unions to exercise sound underwriting, proper risk management, and due diligence, the elements that have kept credit unions well positioned throughout this economic downturn. Further, state regulators are monitoring red flags closely, fully utilizing off-site monitoring and using early warning systems to detect risk.

The growing trend toward consolidation is also on the minds of state regulators as credit union mergers continue to occur, both voluntarily and for regulatory purposes. As economic pressures persist, finding suitable merger partners may become more difficult. State regulators recognize this dilemma and see merger issues as an ongoing concern in 2010.

While state regulators continue to effectively supervise credit union safety and soundness at the state level, they are cognizant of the critical regulatory reform discussions occurring in Washington, D.C. State regulators are concerned about federal financial regulatory reform legislation and what impact it may have on their financial institutions and how they are regulated. Further, state regulators remain concerned about possible negative impacts on state authority and the state’s ability to act in the best interests of their consumers. I explain more in the next sections about state regulators’ perspectives on federal regulatory reform, systemic risk, and consumer protection.

Federal Regulatory Reform

Today’s regulatory system is structured so that the states and the federal government act both independently and in partnership to supervise financial institutions. The dual chartering system for financial institutions has successfully functioned for more than 140 years, since the National Bank Act was passed in 1863.

Since its inception in 1965, NASCUS has defended the rights of state legislatures and state regulators to determine what is in the best interests of their individual state’s consumers. During the Bush Administration, then U.S. Treasury Secretary Henry Paulson released his Blueprint for a Modernized Financial Regulatory System. This proposal called for sweeping changes to the current regulatory system, essentially eliminating the state system and proposing broad regulatory consolidation.

NASCUS believed that the Paulson plan would have adverse consequences on the state-chartered credit union system and opposed the plan from the beginning. State-chartered credit unions have benefited the nation and the states for more than 100 years. The dual chartering concept is based on the important foundation of competition and choice between state and federal charters. Disruption of the current structure would have various negative impacts. It would diminish state and federal regulator cooperation, tip the balance of power between states and the federal government, and minimize the economic benefit and enhanced consumer protections available to states through state-chartered institutions.

The Paulson proposal was met with opposition, and fortunately did not have the support of the 110th Congress. As we entered the Obama Administration, NASCUS and state regulators were hopeful that the new administration would reaffirm the state regulatory system. The President did recognize the value of the state financial regulatory system in his March 2009 recommendations to Congress titled Financial Regulatory Reform: A New Foundation. In the report, the Obama Administration recommends that state supervision and credit union dual chartering should be maintained. The Obama reform proposal also recommends the National Credit Union Administration (NCUA) remain an independent credit union regulator.

As regulatory reform efforts are considered by the 111th Congress, NASCUS and state regulators have encouraged Congress to reaffirm the President’s recommendations and preserve dual chartering and state regulatory authority.

Dual chartering remains viable in the financial marketplace because of the distinct benefits provided by charter choice and the commitment to safety and soundness shared by state and federal regulators. Any modernized regulatory restructuring must recognize charter choice and state supervision. Differing laws for governing state and federal credit unions is positive for credit unions and consumers. Individual institutions can select the charter that will most benefit their members or consumers. Further, state and federal regulators can draw on combined expertise to ensure the entire system remains safe and sound. Congress must continue to recognize and reaffirm the distinct roles played by state and federal regulatory agencies.

The state credit union system is threatened by the preemption of state laws and the push for a more uniform regulatory system. In this Congress, discussion continues on a possible consolidation of regulatory authorities. It is critical that any regulatory consolidation does not threaten state authority or dual chartering. As stated previously, charter choice benefits consumers, provides enhanced regulation, and allows for innovation in our nation’s credit unions. A dual regulatory system also allows for the necessary balance of power between the states and the federal government. In addition, it is important that new policies do not stifle the innovation and enhanced regulatory structure provided by the state credit union system.

Consumer Protection

Enhancing consumer protection is also on the minds of Congress and regulators as the proposed Consumer Financial Protection Agency (CFPA) works its way through the legislative process. The CFPA Act of 2009, passed by the House Financial Services Committee, is now awaiting full House action. At this writing, Senate Banking Committee Chair Chris Dodd (D-Conn.) had introduced a discussion draft including the Senate version of the CFPA as part of his regulatory reform legislation.

The nation’s state credit union regulators, as represented by NASCUS, share a responsibility with our federal regulatory counterparts to protect consumers against unfair, deceptive, and fraudulent practices in the financial services market. NASCUS supports the CFPA concept and enhanced federal consumer safeguards to complement the robust state oversight. However, NASCUS believes that it will be necessary for the CFPA to consult with state regulators in order to ensure robust consumer protection.

As recognized in the House CFPA legislation as currently written, it is clear that legislators understand that the states have built a strong system of consumer protection, which in some cases provides greater protection for a state’s individual citizens. House Financial Services Chairman Barney Frank (D-Mass.) recognized the importance of state regulators in consumer protection by including the FFIEC State Liaison Chairman, a state regulator, on the CFPA’s governing body, as well as formalizing consultation with state regulators throughout his legislation.

It is important that state regulatory authorities are involved in the exercise of the powers granted to the CFPA so that existing knowledge and standards developed at the state level are leveraged to protect consumers to the maximum degree possible. The expertise of state regulators and their ability to more readily identify emerging issues at their local levels will improve the CFPA’s capacity to address issues before they become national in scope.

As the CFPA is considered by the full House and the Senate, NASCUS and state regulators will ensure that the final legislation affirms states’ authority to enact and enforce consumer protection statutes – without the threat of federal preemption. State regulators, who are local by nature, are the front lines of consumer protection.

Systemic Risk

In addition, Congress is studying how to properly address systemic risk in the U.S. financial services system. Certainly, the evolution of the financial services industry and the expansion of risk outside of the more regulated depository financial institutions reflect that further consideration should be given to expanded systemic risk supervision.

By the time this article is published, a discussion draft is expected to have been marked up by the House Financial Services Committee. The discussion draft establishes a systemic risk council and provides mechanisms for large, systemically risky institutions to unwind without taxpayer exposure.

State regulators and their rich knowledge and expertise must have a valued role in the nation’s processes to mitigate systemic risk. NASCUS requests that Congress recognize that the states should have a seat at the table when addressing systemic risk issues. State regulators are in a position to detect problems at the local level before they may become a greater national risk. State involvement in systemic risk mitigation and detection is critical. We have encouraged Congress to formalize the states’ role in systemic risk mitigation as legislation proceeds.

The credit union system is also debating the role of systemic risk with respect to the role of corporate credit unions, “banker banks” type entities that provide investments and payments services to credit unions. In late 2008, the National Credit Union Administration (NCUA) announced that two federal corporate credit unions had suffered large losses from the deterioration of asset-backed securities. The losses and the subsequent NCUA conservatorship of the two federal corporate credit unions are having significant impact on the balance sheets of credit unions.

These events prompted the NCUA to revise its regulations governing corporate credit unions; a proposed rule is expected in mid-November. State regulators have been working closely with NCUA on important regulatory changes regarding systemic and concentration risk in the corporate credit union system. We believe that healthy corporate credit unions should have the ability to continue to provide services to credit unions. NASCUS has also stressed that enhanced regulatory oversight by state and federal regulators is essential for corporate credit unions.

Further as a result of corporate credit union losses, for the first time in nearly 20 years, the NCUA Board approved a credit union premium in September 2009 with the assessment of 0.15 percent of insured shares. The premium will both restore the National Credit Union Share Insurance Fund (NCUSIF) equity to 1.30 percent and begin to repay a portion of the Temporary Corporate Credit Union Stabilization Fund borrowings from the U.S. Treasury.

Given the recent insurance premium, the possibility of additional assessments and the balance sheet impact of the corporates and the economy, state regulators believe that credit unions need more capital options. Capital reform is necessary for the corporate system, as well as for credit unions.

Access to Capital

During the corporate stabilization process, supplemental capital may have mitigated some of the negative impacts on credit union net worth. However, credit unions are the only depository institutions that cannot raise capital outside of retained earnings (with the exception of low-income and corporate credit unions), so acquiring additional capital was not an option during the corporate credit union crisis.

NASCUS and state regulators have long believed that credit unions should have access to supplemental capital. Today’s volatile, ever-changing market has revealed the importance of capital reform for credit unions. Currently, laws governing capital for credit unions rely on statutory leverage ratios, therefore excluding potential sources of reliable capital. These sources could strengthen credit unions and allow them to better meet the credit needs of members, contribute to the liquidity of the financial system, and support economic growth and stability.

To allow credit unions access to supplemental capital, a statutory change to amend the definition of net worth in the Federal Credit Union Act is necessary, followed by state and federal regulations. I cannot stress enough how important this change is for credit unions in this economic environment. As regulators, our job is to protect safety and soundness. We need to make these changes now so that credit unions can rebuild from corporate credit union losses, better react to economic conditions, and prepare for the future.

Certain conditions must be maintained, however, for supplemental capital to be acceptable and properly structured for credit unions. Likewise, there will be strict regulatory approval and scrutiny before credit unions are allowed to raise supplemental capital. We believe such instruments must maintain the mutual and member-owned characteristics of the credit union. Further, they must have a proper structure in terms of maturity and meet safety and soundness considerations. In addition, the instruments must maintain proper disclosures and marketing practices. A working group of state regulators is addressing these issues and other regulatory considerations for supplemental capital with the NCUA. We believe that these conditions can be met and we are hopeful supplemental capital may soon be an option for credit unions.

During these troubled economic times, it would be unwise to ignore any solution that would bolster the safety and soundness of the credit union system and protect the credit union share insurance fund. In this period where credit unions remain safe and sound, it is the appropriate time for them to protect and grow their liquidity. The credit union movement needs access to capital, and this is an issue that NASCUS state regulators believe they should solve as regulators for safety and soundness purposes.

NASCUS will continue its efforts to achieve access to supplemental capital for all credit unions. NASCUS believes strongly that this is an important part of maintaining credit unions' safety and soundness into the future.

* NASCUS Chairman, Deputy Commissioner of Banking and Securities, Vermont Department of Banking, Insurance, Securities and Health Care Administration. He may be contacted at Tom.Candon@state.vt.us.

[1] As of June 30, 2009.

[2] Data provided by the Massachusetts Credit Union Share Insurance Corporation, June 30, 2009.